Appreciation refers to an increase in the value of an asset over time. This usually occurs when the supply of an asset becomes more scarce and/or demand for that asset increases. While, theoretically, any asset can appreciate, appreciation is most likely in assets with an indefinite lifespan (e.g. property). By contrast, assets with a finite lifespan tend to lose value over time. This is known as depreciation.
Examples of appreciation
In the context of business, the most common forms of appreciation are:
- Capital appreciation
- Currency appreciation
- Some businesses may also benefit from real-estate appreciation.
Capital appreciation refers to the increase in value of financial assets. For example, one company may choose to sell part of its operations to another company. It may take some or all of the payment in shares of the other company. If these shares gain value over time, then the first company will benefit from capital appreciation.
Currency appreciation refers to one currency gaining value as compared to another currency. This is often referred to as the “exchange rate”. Currency appreciation can be a benefit if you hold reserves in that currency. If you don’t, however, it can be a drawback because it makes goods and services more expensive to buy.
If a business holds land (e.g. a farm) and/or property, then it can also benefit from real estate appreciation. Both land and property are in limited supply and can generally be used indefinitely. This means that they generally gain value over time.
Why assets appreciate
There are three main reasons why assets appreciate. These are inflation, reduced supply and increased demand.
The term “inflation” refers to the fact that prices as a whole tend to increase over time. They do not, however, necessarily rise equally. What’s more, even with inflation, some assets may still depreciate. This is particularly likely if they have finite lifespans.
Reduced supply and increased demand can both increase the level of competition between buyers. This can translate into higher purchase prices and higher values for assets a company already owns.
How to calculate appreciation
While you own an asset, the easiest way to calculate appreciation is to use the annual percentage growth rate. To do this, take the asset’s value at the end of a year and divide it by the asset’s value at the start of the year. Then subtract one from the result and multiply the answer by 100.
For example, if an asset was worth £100 at the start of the year and £150 at the end, the calculation would be as follows.
0.5*100 = 50
So you have an annual appreciation of 50%
If you then dispose of an asset, you can calculate its total appreciation by using the Compound Annual Growth Rate.
To calculate this, take the asset’s value when you dispose of it and divide it by the asset’s value when you bought it. Then divide the result by one over the number of years you had the asset. Finally, subtract one from the result and multiply the answer by 100.
For example, if you bought an asset for £100 and sold it five years later for £150, the calculation would be as follows:
1.31 = 0.3
0.3100 = 30
So you have a compound annual growth rate of 30%.
Understanding the meaning of appreciation in business
Appreciation can be a double-edged sword for businesses. Recording appreciation on a company’s balance sheet may appear favourable for the company’s financial wellbeing. What’s more, if assets increase in value, it may be possible to put them to work as extra collateral for financing. This may result in more advantageous interest rates and terms for future business borrowing.
On the other hand, if assets increase in value, they may cost more to insure. There may also be tax implications, particularly with real estate.
What are some examples of appreciating assets?
Appreciating assets are those whose value increases over time. Common examples of this include:
- Currency appreciating in value as the country’s economy grows stronger or more stable
- Real estate increasing in value as an area becomes more desirable
- Stocks increasing in value as a company launches a successful new product
What is an appreciation rate?
An appreciation rate is the rate at which the value of an asset grows. Hence, it is also known as the growth rate.
What causes assets to appreciate?
There are several driving forces that may cause an asset to appreciate. These include:
Inflation: Inflation is a natural phenomenon in any economy as populations, jobs and the flow of money into the economy increase. As inflation increases, so can the value of assets
Supply and demand: High demand or low supply of an asset may also cause an asset to appreciate as it becomes more desirable
Financial performance - The financial performance of a company can cause their stocks and even their products to appreciate in value